A few weeks ago, eighteen law professors, including Berkeley Law Professor Robert Bartlett, filed an amicus brief in support of respondents in the pending Supreme Court case, Amgen, Inc. v. Conn. Retirement Plans and Trust Funds. Before the Court is whether plaintiffs using a “fraud-on-the-market” theory of reliance in a securities fraud (10b-5) class action must prove the “materiality” of alleged misstatements at the class certification stage. The brief argues that the histories of FRCP Rule 23 and the fraud-on-the-market presumption show that plaintiffs do not.
Under FRCP Rule 23, plaintiffs in a securities class action are required to show that the elements of a rule 10b-5 claim, including reliance, are common to the class. Reliance typically is shown through invoking the fraud-on-the-market presumption. The presumption, as articulated in the Supreme Court case Basic, Inc. v. Levinson, is based on the theory that most publicly available information is reflected in a stock’s price. Thus, a company’s public material misstatements are reflected in the price at which investors bought the security. “[A]n investor’s reliance on any public material misrepresentations, therefore, may be presumed.” The Court went on to state that materiality is an objective standard, “involving the significance of an omitted or misrepresented fact to a reasonable investor.” The Court did not hold, however, whether a showing of materiality is required to invoke the presumption.
Courts since Basic have held that to invoke the presumption, a plaintiff must prove that the market in which the security was sold was efficient and that the misstatements were public. Circuit Courts split, however, as to whether plaintiffs must also prove the materiality of these statements to invoke the presumption. In this case, the Ninth Circuit joined the Seventh and Third Circuits in holding that plaintiffs do not need to prove materiality at the class certification stage. Rather, the court held that RCM need only plausibly allege materiality.
The amicus brief of the professors urges the Court to affirm the Ninth Circuit’s holding. The brief argues that because materiality is an objective standard, not particular to any individual investor, it is presumptively a common question, thus satisfying Rule 23(b)’s commonality requirement.
The brief also attacks an amicus brief in support of petitioners, written by Michigan Law Professor Adam Pritchard and University of Chicago Law Professor Todd Henderson, which argues that the Supreme Court’s holding in Basic improperly relied upon the efficient capital market hypothesis to justify the imposition of the fraud-on-the-market presumption. Pritchard and Henderson go on to conclude that “[t]he decision below should be reversed because it focuses on efficiency at the class certification stage, rather than on the market effect of the alleged misstatements at issue.”
The professors here respond with a history of the fraud-on-the-market presumption, which they claim dates back to the enactment of the Securities Exchange Act of 1934—well before the development of the Efficient Market Hypothesis. They argue that “[c]riticisms of the Efficient Capital Market Hypothesis fundamentally misunderstand Basic’s holding, which is expressly grounded in the enacting Congress’s understanding that securities markets tend to incorporate publicly available information.” The presumption is not, as Pritchard and Henderson argue, grounded on the efficient market hypothesis. Thus, the brief argues that the literal accuracy of the efficient capital market hypothesis is an irrelevant consideration.